On June 14, 2007, the U.S. Court of Appeals for the Second Circuit affirmed the district court's determination that statements made on an NASD Form U-5 are subject to an "absolute privilege" and therefore do not give rise to liability in a defamation lawsuit. As discussed below, Rosenberg v. Metlife, Inc., No. 05-4363 (2d Cir. 2007), resolved an unsettled issue in New York regarding the protection afforded to National Association of Securities Dealers ("NASD") member firms that are required to state the reasons for termination of a registered representative on a Form U-5. Some New York courts found such statements to be subject to an "absolute privilege," while other New York courts (as well as the Sixth and Seventh Circuits Courts of Appeal, applying the law of Tennessee and Illinois, respectively) ruled that these statements are subject to a lesser, "qualified privilege," which can be overcome by demonstrating that the statements were made with actual malice. The Rosenberg decision should provide comfort to securities industry employers who seek to provide a full and fair explanation of the circumstances surrounding a New York employee's termination without risking increased exposure to defamation or libel lawsuits.

Form U-5

The NASD requires its members to file a Uniform Termination Notice for Securities Industry Registration, known as a Form U-5, within 30 days of the voluntary or involuntary termination of a registered representative and to provide a copy of the form to the employee. The Form U-5 sets forth the employer's statement of the reasons for the termination. In addition, the form contains a number of disclosure questions regarding whether the employee has been subject to criminal charges, customer complaints or an internal review for violating investment-related rules.

Factual Background

Metlife hired plaintiff-appellant Chaskie Rosenberg in 1997 to work as a financial service representative in its All-Boro agency. Beginning in 1998, Metlife initiated inquiries into the All-Boro agency's practice of accepting third-party checks for the payment of life insurance premiums. According to Metlife, third-party payments are problematic because they can be indicative of "speculative insurance practices and possible money-laundering activities." These inquiries evolved into two full-scale audits in 1999 and the closing of the agency. Metlife transferred Rosenberg to a different Metlife agency, but ultimately terminated Rosenberg's employment following the results of the second of two audits. Upon Rosenberg's termination and in accordance with NASD regulations, Metlife filed a Form U-5, stating the reasons for his discharge as follows:

An internal review disclosed Mr. Rosenberg appeared to have violated company policies and procedures involving speculative insurance sales and possible accessory to money laundering violations.

The Form U-5 also indicated that Rosenberg had been under an "internal review for violating investor-related rules."

Rosenberg filed an action against Metlife in the U.S. District Court for the Southern District of New York, alleging, among other things, that Metlife's stated reasons for his termination in the Form U-5 were defamatory and made with malicious intent. The district court dismissed Rosenberg's libel claim, holding that statements made on a Form U-5 are absolutely privileged and, therefore, do not subject the speaker to liability.

Rosenberg argued on appeal to the Second Circuit that the district court erred in finding statements on a Form U-5 to be absolutely privileged and asserted, instead, that they should be subject only to a "qualified privilege." As explained by the Second Circuit, as a general matter, an "absolute privilege" is reserved for communications made by "individuals participating in a public function, such as executive, legislative, judicial or quasi-judicial proceedings" and can also extend to "preliminary or investigative stages" of such proceedings, particularly when "compelling public interests are at stake." By contrast, a statement is subject to a lesser "qualified privilege" when it is "fairly made by a person in the discharge of some public or private duty, legal or moral, or in the conduct of his own affairs, in a matter where his interest is concerned." Communications that are protected by a qualified privilege are not actionable unless a plaintiff can demonstrate that the statement was made with malice.

The Second Circuit determined that Rosenberg presented an unsettled issue under New York State law and, as such, asked the New York Court of Appeals, New York's highest court, to determine whether statements made by an employer on an NASD Form U-5 are subject to an absolute or qualified privilege in a defamation lawsuit.

The Court of Appeals' Decision

Before the Court of Appeals, Rosenberg argued that "the filing of a Form U-5 is too remote from the NASD's quasi-judicial functions to warrant the application of an absolute privilege." Metlife countered by arguing that an absolute privilege should apply because "the filing of a Form U-5 with the NASD is a preliminary step in a quasi-judicial process and because such a privilege best serves the public interest in encouraging full and truthful disclosure."

The Court of Appeals agreed with Metlife and concluded that statements on a Form U-5 are to be afforded an absolute privilege. The court emphasized that the NASD is a "quasi-governmental entity" and one of its "central responsibilities" involves the "investigation and adjudication of suspected violations of the SEC's laws and regulations as well as the NASD's own rules." According to the Court of Appeals, the Form U-5 plays a "significant role" in this self-regulating process and is "often the first indication that the NASD receives regarding possible misconduct by members of the securities industry." The Court further noted that the NASD's investigatory actions "ultimately inure to the benefit of the general investing public, which faces the potential for substantial harm if exposed to unethical brokers." Based on these regulatory and public interests, the Court of Appeals concluded that statements made on a Form U-5 are subject to an absolute privilege in a suit for defamation.

What This Means for Employers

The Rosenberg decision is an important ruling for broker-dealers and should provide comfort to NASD firms that seek to provide a full and fair explanation of the circumstances surrounding a New York-registered representative's termination without exposing itself to litigation risks. Under theRosenberg Court's decision, however, an NASD firm is not immune from all potential liability stemming from allegedly defamatory statements contained in a New York employee's Form U-5. As noted by the Court of Appeals, registered employees who are maliciously defamed on a Form U-5 may commence an arbitration proceeding or court action seeking to expunge any alleged defamatory language.

Furthermore, since the Sixth Circuit (applying Tennessee law) and the Seventh Circuit (applying Illinois law) have each concluded that statements contained on U-5 forms are subject to the lesser "qualified privilege," employers terminating registered representatives in Tennessee and Illinois will not enjoy an absolute privilege for the statements they make on a Form U-5. Employers terminating registered representatives in other states should be guided by the law of the state where the employee is employed.